Ahead of the Curve

The lending environment is undergoing a worrying change. Funds that European direct lenders have raised but not yet deployed are at an all-time high and banks in most Western-European jurisdictions have renewed lending following years of reticence after the global financial crisis, leading to increased competition amongst lenders in the small and medium enterprise (SME) market.

Strategically Speaking: Assicurazioni Generali

It has been just over two years since Generali CEO Mario Greco took the reins of a company whose governance was in disarray, and whose performance was reflected in a loss of almost 75% of its stock-market value. His appointment immediately stemmed those losses, and the market has since been proved right.

“For the very first time after many years, Generali is growing its market share,” Greco observed as the insurance giant’s mid-2014 interim report came out.

New business is facilitated by the firm’s Solvency I ratio going from 141% to 162% during the first half of 2014, already exceeding the target set for 2015. Alongside divestments of non-core businesses, Generali refinanced all of the 2014 bond maturities it needed to by May. In April a 12-year subordinated bond issue that was seven times oversubscribed replaced a non-eligible 2008 issue, as well as refinancing senior debt maturing next year, improving the regulatory-capital position at lower cost. The three major rating agencies had already delivered upgrades in early spring.

But, of course, the investment team, led by CIO Nikhil Srinivasan, who joined early in Greco’s tenure, also deserves credit.

A big call early in 2013 paid off spectacularly in 2014, during the first six months of which the portfolio increased by 7.7%. Srinivasan and his team gradually took the cash level down from 7.5% to 2.5% as part of a general effort to lengthen duration: the move brought assets closer in line with liabilities but, especially after the Federal Reserve’s announcement concerning its quantitative easing (QE) programme, it was also a swim against an increasingly strong tide of opinion on rates.

“Last year our view was that inflation would go lower and yields would stay low,” says Srinivasan. “With US Treasuries in particular we really were on our own.”

There is creative thinking in other parts of the portfolio, too. Private equity has been scaled back and re-focused on opportunistic investments in things like recovery in Italy or Spain, and technology firms in Eastern Europe, for example. But most significant has been a decision to play more aggressively for the illiquidity risk premium. Srinivasan notes that Generali had no head of ALM before he came on board. That vacancy has now been filled, enhancing cash-flow management and facilitating an ongoing project to reduce portfolio liquidity.

An already extensive real estate allocation, relative to insurance peers, is expanding to include development. In July, Generali became sole owner of the company managing the largest development project in Milan. It is developing M&G’s new headquarters in Fenchurch Street, London, as well as an office tower in Paris.

“Our view is that development works well when yields are very low because it promises more upside from capital appreciation,” Srinivasan explains. “That requires big occupancy guarantees from high-calibre tenants, of course; M&G are leasing for 20 years.”

The firm is exploring similar opportunities outside Europe, in places where it has a presence and where its real estate investments would be for its own use, such as in Jakarta, or where it can find good local partners, such as in Japan.

But there is no doubt that the most cutting-edge effort to take more illiquidity risk has been the €20bn or so it has put to work in European private placement markets.

“We’ve become a real leader, well ahead of our insurance peers,” Srinivasan says. “This is about efficiency: we can get decent size and negotiate prices with the issuers, as opposed to waiting for a bank to turn up with perhaps 10% of what we want from a deal. We have gone to sizeable, public bond-issuing companies, and some Italian state enterprises.”

This is not to say that Generali has not also been involved in SME lending, in France, Germany and Italy. But Srinivasan has doubts when it comes to talk of Europe’s lending growing more capital markets-focused as institutional investors step into the gaps left by banks – as the European Commission, the ECB and other authorities would like.

“Insurance companies have to recognise that they cannot supplant the banks,” he insists. “With SMEs we have always worked with banks. I’d rather work with third parties because we simply don’t have the teams in place to do those complex transactions, and never will. I can’t hire 20 people to make loans that will constitute 2-3% of our assets.”

When it does work with a bank, Generali requires its counterparty to retain a meaningful portion of the loan on its own balance sheet. The firm also works with asset managers on direct lending, but Srinivasan notes that here, too, those managers are working with bank-based origination teams. That expertise is essential precisely because the number of deals available is low and competition for them, from around the world, is fierce.

“Other institutional investors talk about working with investment banks to originate loans, but to be honest, given the size of some of these institutions, the number of deals going through is a long way short of significant,” he says.

Aware that institutional investment in infrastructure and SMEs is high on the policy agenda, Srinivasan says that cutting the risk-weighted capital requirement against SME lending would help, but ultimately points out that Europe’s problems are only marginally about bank liquidity and low levels of institutional investment.

Generali Group investments

Total own assets: €347.5bn (June 2014)

• Fixed income: 87%

• Equity: 5%

• Real estate: 4.3%

• Other instruments: 1.1%

• Cash and equivalents: 2.5%

“It is much more important to get confidence back in our economies,” he says. “I think the demand for loans is less than Mario Draghi thinks. Why would you build a factory if you think you might utilise only 80% of the capacity? Bank loan growth lags economic recovery, it doesn’t lead it. The impact of TLTRO [targeted longer-term refinancing operations] and even QE, as we know from the US, will be muted unless it is accompanied by supply-side reforms – as Draghi himself is the first to point out. You have to do what Spain and Greece have done and cut taxes.”

He points to payroll tax cuts and spending cuts in France and urges similar “short-term kickers” to complement long-term reforms in Italy. Against objections that Europe cannot afford this he insists we will have to get used to bigger deficits.

“I think Germany would be supportive as long as there is a larger plan to use that extra borrowing to cut corporate taxes, free-up investment and create jobs,” he says.

Is Srinivasan confident these things will happen? At the moment he sees too much focus on monetary policy – which means his long-duration bet has some life in it, yet.

“There’s no inflation in Europe, which means we are in a low-rate environment indefinitely, almost irrespective of what Draghi does or does not do,” he argues. “One thing I’ve learned from my years in investment is that trends always last longer than people think. We’ve seen low yields in Europe for three or four years now, but there’s no reason why we shouldn’t see them for three or four more.”